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Theory of Cost Micro 6
Theory of Cost Micro 6
CLASS 11
MICRO ECONOMICS
NOTES
THEORY OF COST
The expenditure incurred by a producer on factor as well as non
factor inputs at the time of production is called as the cost of
production.
Cost function
The functional relationship between cost and output is called as
cost function.
C = f(Q)
Where, Q = Output
C = cost
Types of cost
1. Total fixed cost(TFC)
The payments which are made by the producer on fixed factors
during the process of production are known as total fixed cost.
Example Payments on building, machinery etc.
They are generally one time investments and hence they are fixed
in nature.
Other names of TFC are supplementary cost,
Indirect cost,
General cost,
Unavoidable cost.
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THEORY OF COST
0 100
1 100
2 100
3 100
4 100
5 100
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THEORY OF COST
0 0
1 50
2 80
3 100
4 200
5 370
6 580
3. Total Cost(TC)
It refers to the total expenditure which is paid on both fixed and
variable factor during the process of production.
It is the horizontal summation of Total Fixed cost and Total Variable
Cost.
TC = TFC + TVC
The Total cost and Total Variable Cost curve are always parallel to
each other just because of constant Total Fixed Cost..
0 100 0 100
1 100 50 150
2 100 80 180
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THEORY OF COST
At zero level of output TVC is zero.
Which means the Total Cost at zero level of output is the Total
Fixed cost made by the producer.
At zero level of output, TC =TFC.
0 100 ------
1 100 100
2 100 50
3 100 33.3
4 100 25
5 100 20
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THEORY OF COST
5. Average variable cost(AVC) It refers to per unit variable cost of
production It is computed by dividing Total Variable Cost by quantity
produced. It shows the burden of variable cost on per unit of output
produced.Initially, AVC falls with increase in output but once output
reaches optimum level it started rising again.
AVC = TVC/Q
0 0 0
1 50 50
2 80 40
3 100 33.3
4 200 50
5 370 74
6.Average cost(AC)
It refers to per unit cost of production.
It is computed by dividing total cost by the quantity produced.
It signifies the total burden of cost on per unit of output.
It can also be calculated by adding Average Fixed Cost and Average
Variable Cost.
AC = TC/Q or AC = AFC + AVC
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THEORY OF COST
2 100 80 180 90
0 100 ------
1 180 80
2 240 60
3 280 40
4 350 70
5 450 100
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THEORY OF COST
The curve initially slopes downward with increase in quantity of
output produce due to increasing return in the process of
production, after reaching minimum it starts building back as the
rate of production goes down (law of variable proportion).
Real cost All the efforts and sacrifices with the producer made,
at the time of production in monetary terms are known as real
cost.
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THEORY OF COST
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COMPLETE SCHEDULE
Quantity TFC TVC TC AC AFC AVC MC
0 100 0 100 ----- ----- ----- 100
1 100 80 180 180 100 80 80
2 100 140 240 120 50 70 60
3 100 180 280 93.3 33.3 60 40
4 100 250 350 87.5 25 62.5 70
5 100 350 450 90 20 70 100
6 100 470 570 95 16.6 78.4 120
Formula Used
At zero level of output,
TC = TFC
TC = TFC + TVC
AC = TC/Q or AC = AFC + AVC
AFC = TFC/Q
MC = TCn - TCn-1 or MC= ∆TC/∆Q
AVC= TVC/Q
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BEGINNER ADVANCED
THEORY OF COST CLASS 11
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